Fairness and Economic Reality in Business Valuation

In order to be fair, the valuation expert’s opinion must result in a value that is the cash equivalent of what the business owner could receive as of the agreed upon cut-off date.

Fairness Business ValuationThe notion of fairness is the polestar for most professionals entrusted with the resolution of all issues that arise in a family law matter. That concept is no less applicable in the area of business valuation – however, an expert can only achieve fairness in business valuation incident to the dissolution of a marriage or other family-type partnership by basing his/her conclusions upon economic reality. Economic reality requires a conclusion of value based upon concepts of cash equivalency, so in order to be fair, the valuation expert’s opinion and the court’s ultimate decision must result in a “value” that is the cash equivalent of what the business owner could receive as of the date of the filing of the complaint for divorce or other agreed upon cut-off date for purposes of equitable distribution.

The true issue has been obscured by the debate over the standard of value, which sets the criteria upon which valuation analysts rely. An essential step in valuing a business is selecting and then applying the appropriate standard of value, including: fair market value, fair value, intrinsic value, value to the holder, equitable distribution value, or some other standard. Applying the standard involves an assumption as to who will be the buyer and who will be the seller in the hypothetical or actual sales transaction regarding the assets at issue.

Debating Standard of Value

In Brown v. Brown, 348 N.J. Super (App. Div. 2002), the court concluded that the appropriate standard was “fair value” as opposed to “fair market value.” Fair value is a legislatively determined valuation standard applied under N.J.S.A. 14A:11-3(2); fair market value is defined as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. (IRS Regulation 20.2031-1).

In his article “Value to the Holder, Not Fair Market Value, is the Correct Standard to Value a Professional Practice in New Jersey”, Frank Louis, Esq. noted that Brown adopted fair value notwithstanding the Supreme Court’s admonition, albeit in a footnote, that using corporate statutory remedies may not be applicable in a divorce.
Fairness and Economic Reality

Business Valuation

Instead of debating the standard of value, the focus should be on fairness and economic reality.

The most common public policy underlying equitable distribution is a recognition that a marriage is a partnership whose assets should be shared in an equitable fashion. Therefore, with all of the foregoing considered, the appropriate standard that will implement a public policy of fairness in rendering equitable distribution based on economic reality should be as follows:

A non-titled spouse should be entitled to fairly share in the economic value of a business legally or beneficially acquired during the marriage. This value shall be defined as that which the owner could receive at a point in time from market participants (i.e., potential willing buyers) after both parties have considered and analyzed all of the relevant facts. This amount would be the cash equivalent subject to equitable distribution at the appropriate termination date.

The goal of this standard is to fairly compensate and not put an undue burden on the non-titled spouse. Intended to reflect economic reality, this standard is based on the assumption that the asset’s cash equivalent reflects the value of the titled spouse’s interest in the business and will require distribution of nothing more than what the owner could expect to receive from market participants.

Charles F. Vuotto, Jr., Esq. is managing partner of Tonneman, Vuotto, Enis & White, based in Cedar Knolls and Matawan, NJ. Certified by the NJ Supreme Court as a Matrimonial Law Attorney, he is also an AAML Fellow. He wishes to thank Leslie M. Solomon (CPA, ABV, ASA) for his invaluable assistance with this article. www.tvelaw.com